DirecTV unlikely to merge with EchoStar

DavidB. Wilkerson

CHICAGO (MarketWatch) -- Among all of the speculation on what might be in store for DirecTV if a controlling stake is transferred to Liberty Media Corp., one of the most tantalizing has been the prospect of a merger with satellite rival EchoStar Communications.

However, analysts on Thursday said that that's unlikely due to regulatory concerns.

Shares of News Corp.
NWS, +1.64%NWS
advanced Thursday on published reports that it is close to securing an agreement with Liberty Media
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to buy back Liberty's $11 billion stake in the entertainment giant, avoiding a giant tax hit in the process. See full story.

In 2002, the Justice Department blocked EchoStar's
DISH, -1.55%
bid to acquire GM Hughes Electronics, the parent of DirecTV, saying that the number of competitors in rural markets would drop to two from one. "Absolutely nothing has changed on that score since 2002," wrote Craig Moffett, an analyst at Sanford Bernstein & Co., in a note to clients Thursday.

Such a merger is impossible, according to Steve Mather, satellite analyst at Sanders Morris Harris in Los Angeles, until the regional Bell telephone companies have at least 5 million to 10 million video subscribers. After years of competing with cable for high-speed Internet and voice customers, some phone companies have recently rolled out video services.

Once the phone companies have penetrated the video market in a meaningful way, regulators would be less likely to see a merger of the two dominant satellite providers as an anticompetitive threat, Mather said in an interview.

In the meantime, DirecTV
DTV, -2.12%
must find a way to kick-start subscriber growth, which has slowed down in the face of more rapid acceptance of cable's "triple play" bundle of digital video, digital phone and broadband services. It must also stave off the less-imminent threat of the phone companies.

'John Malone's not going to take the leverage to five times [EBITDA], but he's going to take it up.'
Matt Harrigan, Janco Partners

In the third quarter, DirecTV picked up 165,000 net subscribers, shy of the 205,000 average estimate of analysts polled by Thomson First Call. Part of this shortfall stemmed from installation and customer-service problems, which Mather said can be resolved.

In the second quarter, gross additions dropped 10% from a year earlier, but DirecTV said that the figure was impacted by the company's tougher credit standards and a restructuring of its network of third-party dealers.

Liberty Media Chairman John Malone's response may be to "be more aggressive in testing new ways to generate revenue," Mather added, because DirecTV will represent a bigger part of Liberty's strategy than it currently does to News Corp.
NWS, +1.64%NWS

On News Corp.'s watch, DirecTV expressed little desire to rush in finding an application that could equal or surpass cable's triple play. It has looked into the possibilities of using wireless technologies, such as WiMax, to offer a broadband alternative. In the interim, it has a deal with broadband access provider EarthLink, signed this year, and a long-standing agreement to offer local and long-distance phone service from BellSouth.

Sanford Bernstein's Moffett said that a potential stumbling block for DirecTV is that for some time it underspent on high-definition upgrades of its channels, and even now that it has upgraded significantly, it will need to spend heavily on marketing to make sure consumers get the message.

The company is on track to offer more than 150 HD channels nationally by fall 2007.

Analysts point out that DirecTV's debt situation is more favorable than most video providers, with gross debt standing at $3.4 billion, giving Malone some flexibility should he acquire the company. Its gross debt to about one time Moffett's earnings before interest, taxes, depreciation and amortization estimate on the company.

"Malone's not going to take the leverage to five times [EBITDA], but he's going to take it up," said Matt Harrigan, cable and satellite analyst at Janco Partners.

One possibility is that Liberty could pay out a special dividend of as much as $7 a share, according to Moffett.

Liberty will find DirecTV useful in securing better carriage for many of its programming assets, such as the home shopping channel QVC, added Harrigan. "QVC's channel position on DirecTV is not in a great spot, so I'm sure they'd bump that up. And they can use the regional sports networks to improve DirecTV's sports position."

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